[quote=davelj]I mostly agree with Breeze and peterb. There’s nothing inherently wrong with fractional reserve banking and it has one enormous advantage over non-fractional reserve banking: lower interest rates. Look at the interest rate spreads between mortgages and government debt in countries where there is no or limited fractional reserve banking – they’re through the roof. Why? A thought experiment to explain part of the reason. Let’s say I want to start a bank and earn 10% on my equity. Fractional reserve banking allows me to lever up my equity, thereby lowering the necessary spread between my cost of borrowing (deposits) and lending (loans). Holding return on assets constant, my return on equity increases with leverage. So, let’s say I can lever 10-1, earn 1% on assets and achieve a 10% ROE. Now, let’s eliminate fractional reserve banking and now I have to fund entirely with equity. Now I have to earn a 10% ROA. If my cost of deposits is 3% and operating costs are 2%, then I have to charge 15% on my loans to make it worth my while. Anybody want 15% mortgages? Then eliminate fractional reserve lending and your wish shall be granted in short order.
Personally, I don’t have a problem with 20% down mortgages. Recall, that without the 0%, 5%, 10%, etc.-down mortgages, we never would have had the bubble in the first place, so the 20% down mortgages wouldn’t currently be in jeaopardy. That is, if we had stuck to 20% down over the last 8 years we wouldn’t be in this mess in the first place. [/quote]
Banks don’t loan money and the same rate the pay depositors… There is always a 3-6% margin. But the bank’s return is more than 10x the depositors return.
If the bank pays 3% to depositors and charges 5% for loans, at 10:1, the bank would get 50% for every 3% paid or 47% revenue on deposits. The problem in your 10:1 scenario is 9 dollars will get redeposited in the banking system and show up as additional deposits. Now, the bank can loan another 8 dollars on the 9 dollars deposited that the bank ‘created’ and so on. It becomes not just 10:1, but about 56:1 in money supply. So, the bank makes 280% and pays out 30% or 250% revenue on deposits. Based on this, Depositors should be getting returns above the percentage of the loans, not below.
A bank has $100M on deposit. At the end, of the year it will have $47M in revenue without using any of its own money. Now, what do you think the current reserve policy of banks is 10%, 5%, 3%???
Transactions is 10%. All other accounts (Savings, CD’s, etc.) 0.00000% … ZERO, NIL, NOTHING, NADA… This is money value not created by Congress.
This is the 2nd source of inflation and the devaluation of the dollar. Who pays for this inflation? We all pay for this inflation to the banks because everyone increases their prices to pay for this interest. Of course if the bank does not have the hard currency on hand, it must borrow it from the fed at the current Fed Fund Rate which is by the way ZERO… Would you please recalculate the ROA or ROE based on these facts.
Let’s see, I can use someone else’s $10M in deposits and receive $4.7M revenue. Pay for my overhead (employees and facilites) about $1M. Pay myself $2.7M and contribute $1M to every Congressmen in my state and to both the Democrat and Republican parties. That should cover all my bases… I think I will start a bank…
At 20% reserve, the bank should be able to make a nice profit. Buying a house and putting 20% down would be the almost the same risk as lending from deposit at 20% if the housing market is stable. But if you don’t fix the deposit reserves to the same 20%, the bank will take the down and put it out on loan causing higher risk.
In some countries, the cash reserve ratios have decreased over time (sourced from IMF Financial Statistic Yearbook):
Country 1968 1978 1988 1998
Germany 19.0 19.3 17.2 11.9
Turkey 58.3 62.7 30.8 18.0
United Kingdom 20.5 15.9 5.0 3.1
United States 12.3 10.1 8.5 10.3
(Ratios are expressed in percentage points.)
The recurring theme is banks tend to decrease reserves during highly speculative times to make the most money. The Government should increase the reserves during these highly speculative times. However, the problem is the government wants to also expand during these times. I’m not completely against fractional reserve banking, only the amount and the lack of control of the reserves.
